The value of a valuation

Owners of privately held companies do
not always know how much their
company is worth. At times, they are too engrossed in overseeing their every day
business operations to pursue a professional analysis to determine the value of
their assets, which can be used to establish
a fair market value for investors or buyers.

An occasional business valuation can be
a helpful tool for owners’ strategic planning purposes. Ideally, business owners
should not wait too long to decide what to
do with their company or determine how
significant the company’s value is in their
financial portfolio.

Smart Business spoke with Roger T.
Gingerich, CPA/ABV, CVA, a principal with
Skoda Minotti, to learn why business valuations should be a regular part of a business owner’s strategic planning “check up,”
what they involve, and why they should be
done by certified analysts.

Are business valuations ever required?

They can be, e.g., for estate tax or gift tax
valuations for IRS purposes and, often-times, for divorces. For example, business
valuations are required when settling an
estate in order to support the value of an
owner’s company or business interests.
The IRS wants to know how parties calculated the value of the business interest in
the company. The same holds true with
‘gifting.’ If owners want to give their shares
of stock or ownership interest in a company to their children, the IRS will require
data supporting the value of the gift.

Should business owners retain professionals
to conduct business valuations?

Definitely. There are organizations that
certify valuation professionals, such as the
National Association of Certified Valuation
Analysts (CVA) and the American Institute
of Certified Public Accountants (ABV). The
IRS specifically says in its rules that people
who represent themselves as business valuation professionals should have the proper credentials. So, business owners whose
valuations deal with estate or gift taxes are
advised to hire certified valuation professionals. In fact, that is advisable for all business valuations.

In what other cases are valuations recommended?

Business valuations are recommended
when owners are selling their company or
getting involved in mergers and acquisitions. This ensures that the fair market
value is acceptable to all parties involved in
a transaction. Often, people who are selling
their companies think that their business is
worth more than the market can bear.
Buyers, on the other hand, want to find
every angle that will help them generate
the best purchase value possible. The truth
lies somewhere in the middle. A business
valuation analyst can consult with both
buyers and sellers to help them meet reasonable expectations and get the best deals
they can.

What criteria are involved in a business valuation?

Two common areas are the underlying
net assets and liabilities of the business —
such as a cost approach — and the future
benefit stream, such as earnings, dividends
and cash flow. The analyst has to determine, as closely as possible, a rate of return
that a buyer or investor would want in a

Another factor considered is a company’s
ability to turn investments into cash flow. A
privately held company cannot ‘buy and
sell itself’ every day in the stock market, as
public companies do. So, valuation analysts have to apply a discount for a lack of
marketability. That involves privately held
companies’ inability to turn their investments into cash flow within a three- to
four-day time period, which has a negative
impact on their values.

Does a valuation have to include an entire

No. There are situations in which analysts value a fraction of a company or one
owner’s stake instead of the whole business. All things being equal, an analyst who
does only a percentage of a company will
arrive at a different value for that part than
for the entire company. For example, a valuation for the owner of 10 percent of a
company, which is owned 90 percent by
another individual, might involve intangible issues like lack of control. A 10-percent
owner who has little or no control over a
company cannot make policy or business
decisions without getting the majority
owner’s consent. So, buyers or investors
will not pay as much for the 10 percent as
they would the 90 percent.

What will business owners learn from a valuation?

One thing is the owner’s net worth. The
business is usually one of the owner’s
biggest portfolio assets. The knowledge
gained from a valuation is essential if the
owner is doing personal financial planning
or long-term planning. Valuations also
uncover what will impact the business,
both negatively and positively, and lead to
recommendations to help the owner mitigate the negative factors and capitalize on
the positive factors to improve the overall
value of the company. Part of what the
business owner derives from a valuation is
a road map to enhance the company’s overall value going forward.

ROGER T. GINGERICH, CPA/ABV, CPA, is a principal with
Skoda Minotti, based in Mayfield Village. Reach him at (440)
449-6800 or [email protected].